More PIE for all

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Consensus has it that the rich are getting richer, the poor are getting poorer, and the middle class is barely staying afloat – essentially, that the slice of the economic pie enjoyed by the rich is getting larger at the expense of everyone else.

Research I've completed with Philip Armour of Cornell University, Kosali Simon of Indiana University and Jeff Larimore of the Joint Committee on Taxation shows that this “fixed pie” view of the economy is mistaken – growth in after-tax household income was substantial across the entire income distribution spectrum over the 30 years before the Great Recession hit at the end of 2007.

Rather than being applauded for providing valuable goods and services, helping to create jobs and paying their “fair share,” top-income Americans have been turned into villains in an income-inequality story line that urges raising their taxes. The foundation for this tale starts with the well-known research of French economist Thomas Piketty and California's own Emmanuel Saez, which shows that the percent of taxable market income (e.g. wages, interest, dividends, etc.) going to Americans in the top tax brackets is at its highest level since at least 1917.

This is true, but it's also misleading. Piketty and Saez answer the technical question of how taxable income earned by tax units – i.e., a single filer or a married couple filing jointly, unadjusted for the number of dependents – has changed over time. But that answer has vastly different real-world implications from the answer to this question: How has American households' access to after-tax resources changed over time?

Consider: Government-provided Social Security benefits and the Earned Income Tax Credit flow in much greater proportion to lower-income Americans than those in upper-income quintiles; our income tax system also takes progressively more from higher-income households. Fringe benefits and nonwage compensation (employer-provided health insurance, for example) have also become a much larger portion of workers' compensation, as have the value of Medicare and Medicaid health insurance for the aging and the poor.

Because Piketty and Saez's numbers focus only on taxable market income, they miss these additional sources of income and the progressive effects of our tax system on after-tax resources. And, by focusing their analysis to individual tax filing units, unadjusted for the number of persons residing within them, they miss changes in the composition of American households (i.e. an increasing number of households that are made up of unmarried single tax filers who share their income).

These seemingly minor differences in measurement turn out to yield dramatically different changes in the after-tax resources available to all Americans.

Consider the chart above. The blue bars depict changes over time in the measure of income used by Piketty and Saez, which I call conventional wisdom. But the red bars show, that method is a very poor measure of what has actually happened to the after-tax resources available to Americans across the income distribution spectrum during this period. If you take into consideration unmeasured shifts in household size and the tax units within them, the taxes and transfers of government, and the increasing importance of employer-provided health insurance, a vastly different picture of growth emerges than the conventional wisdom suggests.

The rich did get richer over this period; but so did the middle class, so did the working class, and so did the poorest. Instead of seeing their income shrink by 33 percent, the bottom quintile experienced household after-tax income growth of 32 percent.

Far from stagnating, the middle quintile has seen their after-tax income grow by more than a third.

In short: The growth in the productivity of Americans in the top tier of tax units (as shown in the blue bars on the chart) increased the size of the economic pie sufficiently to fund the major gains across the distribution of after-tax income, shown in the red bars.

Why is this important? Our research shows that the years that elapsed between 1979 and 2007, over which top marginal tax rates were substantially reduced, were generally good for all Americans. Yes, the rich got richer, but so did everyone else. Similarly, the Great Recession had a negative impact on the poor and the middle class, but it also hit those in the top income brackets.

Rather than scapegoating top income groups and further delaying recovery with counterproductive increases in top marginal tax rates, Washington policymakers should focus on policies that will encourage the private market investment and innovation that powers economic growth and enlarges an economic pie that can be shared by all.

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